As Malaysia enters a new phase in its oil and gas industry, the country received heartening news in mid-February with a large discovery off the shores of eastern Sarawak.

"This is very good news for a sector that is facing declining annual production and the prospect of running out of hydrocarbons that fuel its economy in a space of 15 years and its Economic Transformation Programme (ETP)," said the Oxford Business Group (OBG), a business intelligence consulting group.

It said the discovery should help to temporarily halt Malaysia's slow declining oil and gas output, dovetailing nicely with moves to boost exploration and production from marginal and deep-water prospects.

Drilled from between 3,000 and 4,000 metres below sea level, the wells offshore eastern Sarawak tapped deposits totalling an estimated 79.28m cu metres of gas and approximately 100 million barrels of oil.

Now Petronas has put into action a plan to extract 1.7 billion barrels of oil from both existing, or "mature", and marginal wells.

OBG said with declining production added to increasing crude prices, oil fields that were once too expensive to exploit have now become prime targets for exploration and production (E&P).

To attract investment and E&P companies to these wells, the government has revised the Petroleum Income Tax Act with new tax exclusions for domestic investment in certain oil and gas fields.

The incentives are designed to draw foreign private investors for marginal field E&P and capital-intensive deep-water projects.

Additionally, the government hopes to use the plan to exploit its marginal fields as an opportunity to boost the economy over the next two years, said OBG.

"This involves investing billions of ringgit to recover oil in the marginal fields and encouraging independent Malaysian companies to become development and production (D&P) companies working under newly designed service contracts." it added.

Marginal oil fields are defined as low-producing fields with concomitant higher production costs, making them less profitable than regular fields. Malaysia has 106 of these, which are thought to contain about 580 million barrels of oil equivalent cumulatively.

OBG said the new risk service contract (RSC) that Petronas is now implementing is a different breed altogether from previous contracts. These contracts allocate ownership of the marginal oil fields to Petronas, which in turn will pay a consortium of D&P companies for their services after production has commenced.

Petronas takes on the majority of the risk here, and the consortium's profit is based on the price of oil and by taking an equity share in the assets.

In early February, Petronas awarded the first RSC to a consortium made up of Petrofac, with a 50 per cent stake, and two local firms - Kencana Energy and Sapura Energy Ventures - with 25 per cent each. The contract is to develop an oil and gas field in Berantai offshore Terengganu at an estimated cost of RM2.44 billion (US$800 million).

Some of the companies rumoured to be interested in the service contracts are niche players already in Malaysia, such as the UK's Petrofac, the Texas-based Newfield Exploration Company and Sweden's Lundin.

Other names being circulated - Perenco, Roc Oil, Petro-Canada and Salamander Energy - are not currently in Malaysia, but are thought to be interested in the contracts because they could bring the expertise and technology necessary, such as enhanced oil recovery (EOR), to exploit marginal fields.

Whatever their eventual makeup, the consortia would have to be well capitalised: Petronas has indicated that developing marginal fields would require RM730 million (US$238.9 million) per field - a high price of admission for non-majors.

They would also be required to allocate a minimum of 30 per cent of their equity to local partners, presumably the new local D&P companies, said OBG.

Expansion in production, however it is achieved, is key to the government's ETP, which relies on oil and gas to provide 14 per cent of the gross national income by 2020.

This may explain why, over the next three years, Petronas and its contractors expect to drill more than 50 exploration wells offshore, OBG said.

Questions are also being raised, however, as to whether the government's reliance on non-majors to play key roles in this undertaking is reasonable.

Yet, if Malaysian D&Ps can rise to the challenge and learn from the experienced niche companies, local outfits could someday be regional or even global players in a technology that, sooner or later, many hydrocarbons-producing countries will have to lean on, said OBG.

Over the years, the contractual side of Malaysia's hydrocarbons industry has undergone a series of changes, beginning with the introduction of the production-sharing contract (PSC) in 1976.

Previously, the government operated a concession scheme in which oil belonged to foreign oil companies and the authorities were allowed only to levy taxes and extract royalties on the proceeds.

After 1976, Petronas's PSCs converted the concession system into a production tranche-based fiscal system, and Petronas took over ownership of the country's oil and gas reserves.

Under the PSC, contractors (oil majors such as Shell and Total) bear all risks and provide all financing for the E&P. In return, they receive a share of the total production recovered from their fields.

The PSC was altered in 1985, 1994 and 1997 to attract foreign investment and companies with experience in deep-water exploration, development and production and to allow for "higher-risk subtle plays" or enhanced oil recovery (EOR) respectively.

Petronas has again tweaked the rules and is banking on the RSC to work things out in the country's favour.